Description

SUMMARY

COIN is over-earning and has begun losing significant market share while customer acquisition cost is ballooning. Fees will likely continue to meaningfully compress given fierce competition & a negative impact from the mix shift to institutional. 3P data suggests retail volume & users have peaked and appear likely to continue declining. The significant operating leverage in the business will likely drive a disproportionately negative impact to margins driving 2023 revenue ~20% below & EBITDA ~30% below consensus.

BUSINESS MODEL

1)       Retail Transactions (87% of total revenue; 32% of trading volume)

COIN generates the majority of revenue through charging transaction fees to retail users. It earns a blended 1.2%, comprised of ~80-200bps from its core Coinbase retail app & ~25bps from its Coinbase Pro app. ~80% of revenue is from the US, up from ~76% in 2020.

2)       Institutional Transactions (4% of total revenue; 68% of trading volume)

COIN earns a blended 2 basis points spread on institutional volume. COIN serves institutional clients such as SQ, PIMCO, Tesla, Third Point, PNC Bank, and WisdomTree Investments. Institutional accounts for 68% of total trading volume, but only 4% of transaction revenue given the substantially lower fees.

3)       Subscription & Services (9% of total revenue)

The largest components are Staking revenue, where COIN takes a ~25% share of all staking income, and Custodial fee revenue, where COIN takes a percentage of the value of customer crypto assets held under custody. Other Subscription & Services revenue includes Earn, which is a crypto marketing tool, Interest Income, and Coinbase Cloud.

THESIS

1.   COIN is over-earning and has begun losing significant market share while customer acquisition cost is ballooning

While COIN is the largest exchange in the US, globally it has fallen to the #3 position. It now appears as though its US user base is over-penetrated. As of 4Q21 it had 89mn monthly verified users, of which ~80% is US. This implies ~55% household penetration. 

We’re seeing other exchanges (e.g. Crypto.com), brokerages (e.g. HOOD) & fintechs (e.g. SQ) not only offer competing services but begin to show meaningful volume. While COIN used to be the global leading exchange, it has been steadily losing share to new entrants. In the last 8 months market share loss has accelerated. Notably, new entrant Crypto.com has had a meteoric rise, driven in large part by its substantial marketing push. E.g. it bought the rights for Staples Center, sponsored the 76ers & the Formula 1, and has released promotional videos featuring Matt Damon. Crypto.com has shown it is possible to “buy” consumer trust, which is one of the largest criteria novice traders (COIN’s bread & butter) have when choosing a platform.

At almost the same time as market share losses started accelerating, customer acquisition cost started sharply deteriorating. Customer Acquisition Cost as measured by verified users increased by +470% y/y in 2021, and as measured by transacting users it increased by +170% y/y.

Market share losses have accelerated in the last 9 months...

...while customer acquisiton cost balooned.

2.   Fees will likely continue to meaningfully compress given fierce competition & a negative impact from the mix shift to institutional.

COIN currently earns ~1.2% on retail trades vs. an average 0% commission for retail stock trading; competitors offer 0.1-0.5% spreads. Specifically, FTX, One of COIN’s largest competitors globally, but not yet meaningfully in the US, was consistently flagged in industry conversations as the biggest threat to COIN. A senior former COIN employee shared that, “FTX is going to win. Everything will factor into FTX. FTX will be the brokerage for everything.” While I am not making this call, the sentiment was echoed by the majority of industry players I interviewed. FTX is expected to start their marketing push when the SEC begins giving regulatory guidance, expected late this year or early next.

The next driver of Bitcoin/Ethereum is likely to come from institutional demand, which will still drive fee compression as COIN only earns 2bps on intuitional volumes. Currently, formers shared that COIN manages their institutional business strictly to maintain liquidity on the books and that it is run at breakeven margins. SQ’s Cash App is one of the largest sources of Bitcoin volume in the US and it uses a white labeled version of COIN. It is treated as an institutional customer. As additional brokers & fintechs partner with COIN, volume will be effectively funneled from the profitable retail segment earning ~120bps spreads to the institutional segment earning ~2bps spreads at breakeven margins.

Another bull driver is the international opportunity. If COIN finds success internationally, fees will also need to significantly come down, as this is where the most competition is. E.g. the 2 largest competitors, Binance & FTX, charge 5-20bps retail spreads.

COIN charges ~7x more than industry average…

…and the pace of fee compression has accelerated negatively over the last year.

3.   3P data suggests retail volume & users have peaked and appear likely to continue declining. Given the significant operating leverage in the business, this will likely drive a disproportionately negative impact to margins.

Volume began rolling over earlier this year & the trend continues to deteriorate. COIN reports 1Q on 5/10, and I estimate they will miss 1Q revenue by ~15% & 2Q by ~20%. 2Q QTD is tracking to -30% below current consensus. Given the public nature of the blockchain, 3P data has a very high correlation: 99.96%

Approximately ~60% of COIN’s cost base is fixed, causing the flow through of lower volumes to disproportionately negatively impact margins.

Additionally, COIN has guided to stepping up investment in R&D and headcount this year, increasing by ~$2bn, or +100%. Said another way, COIN is getting hit by lower volumes, which flow through to a greater negative impact to margins, while entering an investment cycle. While I estimate 2023 revenue ~20% below consensus, I estimate EBITDA ~30% below.

Trend continues to deteriorate, tracking significantly below consensus. 

RISKS

1.       COIN is correlated to crypto prices.

The majority of revenue is not directly tied to crypto asset prices. Subscription & Services are largely tied to the value of crypto assets in the COIN ecosystem and is sensitive to crypto asset prices, whereas transaction revenue is more sensitive to crypto asset volatility. You can hedge some of the crypto market risk out by being long a combination of BITO US & an Ethereum ETF (e.g. ETHX CN & ETHE US).

2.     COIN may find success with its NFT launch.

       The popularity of speculative NFT trading exploded last year & COIN recently launched the beta of its NFT platform. Initial feedback for the platform is skews disappointing. The platform is attempting to merge social media (circa Instagram) with an NFT marketplace. The NFT market has substantially cooled with OpenSea volume dropping over 50% from ~$5bn in January to ~$2.5bn in March. Volume for 2021 was ~$14bn. If we assume COIN is able achieve 50% of OpenSea’s scale & charge the same take-rate, it would imply a ~3% lift to revenue. This is likely aggressive, as a clone to OpenSea launched in January called LooksRare & not only offered a lower fee rate, but they also paid users to buy/sell on their platform. This attracted massive volume of wash traders looking to harvest the rewards, but real volume only reached <10% of OpenSea

3.     International & institutional may drive future volumes above my estimates.

       COIN has been trying to increase its international presence for years, but has consistently lost to competitors, such as FTX & Binance. These competitors charge retail users ~10-20bps, so even if COIN were able to make inroads, they would need to drastically cut fees in order to compete. Institutional is an increasing driver, but it is dilutive to take-rates. COIN would have to grow its institutional volume by ~900% to $11 trillion to make up for this year’s estimated lost retail revenue.

ESTIMATES & VALUATION

Base Case:

§  Assumes 2Q volumes at current tracked QTD trend, which recover sequentially by +10% in 3Q & +20% in 4Q, then grow 37% y/y in FY23.

§  Customer acquisition costs are flat in FY22-23 despite expanding ~500% in FY21. Volume per user bottoms in 2Q & recovers by +20% in 2H22.

§  Retail take-rate compresses ~10% in FY22-23 vs. ~15% y/y compression in FY21.

§  Assumes the low end of mgmt’s investment guidance for FY22 & holding the absolute level of investment flat into FY23. Assumes stable transaction expenses as a % of revenue.

§  Implies 2023 revenue ~20% below & EBITDA ~30% below consensus.

§  Applying a 13x EBITDA multiple to FY23 estimates yields $90. This implies ~3.1x 2023 base case sales. COIN is currently trading at ~19x consensus 2022 EBITDA & ~4.3x 2022 sales. 

Catalyst